Business, Legal & Accounting Glossary
Change in demand is a summation of income effect and substitution effect of a price change. In very general terms, a change in the price of a commodity is reflected by a change in its demand. Under normal circumstances, demand for a product is inversely proportional to its price, i.e., demand for a product or service increases with a fall in its price and vice versa.
A change in the price of a commodity either increases or decreases the disposable income of a consumer. This change in disposable income resulting from a price change affects consumption behaviour. Any change brought about in consumption pattern of a good or service due to a change in its price is termed ‘income effect’
Income effect for normal goods is positive, which means demand and price of said good are inversely proportional to one another. In case of inferior goods, income effect of a price decline has a negative effect on its demand as substitution effect is greater. There are certain commodities categorized as Giffen goods, in which demand rises with an increase in its price, which actually happens in times of panic purchase. Consumers anticipate a further increase in the price of a product in times of scarcity which prompts him to buy more of a commodity even at a higher price.
Thus income effect can be summarized as a change in spending power on demand for a commodity resulting from a change in its price. It is assumed that the price of other goods and services remain unchanged.
A normal good is a commodity for which demand increases with an increase in income of the consumer. Consumer durables, like home theatres, cooking range, branded clothing are a few examples of normal goods. The Income effect of a price change of a normal good is always positive.
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This glossary post was last updated: 29th March, 2020 | 7 Views.